The Only Real Edge: Trading from Breakeven

I'm starting this thread inspired by tight Depth-Of-Market trading in futures, which sheds a totally new light on the FX market for me -- because the Forex market is the same as any exchange traded market and the same principles apply, yet many traders, and especially those starting out, are ignorant of them. Of course, we don't see DOM, but the principle still applies.

The goal of this thread is to explore trading with very tight stops and the fundamental concept of making profit in the markets:

a) that profit is made only from breakeven upwards;
b) that the name of the game is stop-running: players are pushing prices in tight ranges to unload into stops;
c) that the intention and capacity of market movers is unkown beyond the next few ticks (and that's why you have only 10-lines deep on the DOM, the rest is irrelevant);
d) that price action and TA is only good for identifying the points of contention and potential targets/magnets, but not future direction;
e) hence the true edge lies in the ability to catch a breakeven position with lower collateral cost than a 2-8 tick target and hold runners from there if momentum emerges.
For me this basically means one thing -- trade anything, with trend, countertrend, breakouts, but always with very tight stops and hold to reasonable targets from there. That is the only profitable way of trading I have experienced in more than five years.

To expound on the concept for discussion, below is a video by John Grady that basically sums it all up, which makes me want to throw conventional things like wide swing stops and profitable "setups" out the window. If the market moved two ticks in one direction, it can easily move two more, or four more, or grind forty more for that matter -- as long as there are stops to unload into, and no real opposition. This is very clear to see on the DOM in futures, less so in FX.

If the big players who enter and get out on pullbacks to their breakeven position, how can a retail trader make a profit by staying in? If the big guys keep fading expanding ranges and get out immediately and step aside if they don't get BE right away (which actually makes the ranges expand), how can a retail guy sustain them? So, here's the point to discuss in this thread -- and how it could be applied in FX trading:

Ill start perhaps by presenting some logic behind this way of trading. I wish I was taught this when I was still a newbie, this would have saved me a few thousand bucks

So the first thing we know for sure the edge is in a breakeven position, as explained by John Grady above. This is a fact of life nobody has ever made money by holding a losing trade. Of course, if a losing trade came back to breakeven, and then went in favour, money could be made, but it was made only from the breakeven up.

Given this fact of life, there is logic in the following approach: since transaction costs are very low (half a pip for retail traders, and probably close to zero for institutions), the logic dictates that once a breakeven position is entered and goes into profit at least a pip or two, it does make sense to take partial profits, and move the initial stops to breakeven overall -- this is your edge, you ca then sit back and just watch. You can always re-enter at the same price, at a better price or a worse price, but youve netted some profit already. Several options are available for the booked partial position: do nothing, enter it as a limit order at the same price, at a better price, hold it for later or hit the market with it or trail it as a limit order at a worse if momentum begins. But in any case youre in the money on that trade idea already. Basically, that is the high-frequency game scenario of institutions, and we know that most of trading is high frequency algorithmic trading nowadays. What does an algo look like in real life? It's a DOM, with the trader's limit and stop-limit orders dancing around the inside market as the DOM and Time & Sales data keeps changing and the algo keeps adapting. If youre trying to beat that with wide stops and some nonsense like a favourable theoretical expectancy based on hypothetical risk-reward wishful thinking, beware

It is not impossible to replicate that game style manually, or one can create an algo for oneself, too. After all, the idea is very basic the edge is in a breakeven position, and some good things of varying degrees will happen 30-45 pct of the time once youre in.

If no breakeven position is obtained, there are two options available: exit immediately, sustaining a small loss of anywhere between just transaction cost (commission) and a pip or two, or scale in lower to exit the wrong entry near BE and lock in the second entry. But these costs add up pretty quickly to a full 10-pip loss if skill is lacking, however.

So what pro traders do at prop firms and funds is learn the skill of frugal entry, doing many different exercises, like trying to make five ticks in 10 minutes, trying to get a few consecutive winners in a row, etc. The story goes, as confirmed by John Grady and others, that pros dont even look at charts when trading -- they trade around predetermined/planned levels off the DOM ladder.

Futures guru FT71 calls this "campaigning around a position" i.e. trying to get a BE position, scaling in a couple of ticks if it goes against you, exiting the negative entries on pullbacks near breakeven, making partial exits with a profit of a tick or two and just waiting for the bigger breakout in you favour, then chasing with limit orders.

The same technique is described in Mike Belafiores book The One Good Trader as cashflow: entering, taking tiny losses on no-move entries, compensating with tiny partial profits on a tick or two for cashflow and building up a position near BE with minimal risk.

In forex, I find the same principles can be applied by applying the technique to a trade idea (i.e. a setup), without giving too much significance to the setup itself, but playing around it off the tick chart. On a good day, like yesterday, the result is many entries and exits. Normally one is slightly in the red before a move happens, but when it happens, it may run 10 or more pips and then the position is scaled out and some of it still left at breakeven for a longer swing, should one happen. If the move is in the opposite direction, the small losses have to be accepted. Sometimes, if one is selective about entries, even failed countertrend entries against strong momentum end up as breakeven or small profit.

I attach a chart below to give a rough idea what entry and trade management looks like and will try to go into some technical detail in future posts.

The biggest advantage of this approach (shall I call it method?) is that it gives you a great feeling of freedom as you don't have to worry about the goodness of setups and their risk-reward expectancies. All you have to watch is your P&L on the day and keep your own emotions, greed and position size in check, which is no easy feat, but that's another topic for discussion. Another benefit is that you don't have to worry about missing out on great trades -- because you know you can enter pretty much any idea very tight off the tick chart. And there is much less itching experienced when staying flat.

So, my main point is that this tight play, if mastered (of which I do not consider myself a master yet -- just seeking to improve on it), eliminates all the fear -- because you actually enter the fray of very tight ranges, which are not that awe-inspiring, because you don't risk much and the chances of getting a BE position are fairly good, if you fade well. Just try watching the tick chart for a while and, as per John Grady's description, try to imagine who is pushing whom, whose stops are in danger, who is in greater pain -- fresh buyers, or sellers, earlier buyers or sellers, those chasing the move because they are afraid to miss out. Watching a 1- or 5-minute chart for indications of who are the latest guys trapped or eager to get it is also helpful. Once you grasp the ebb and flow of climaxes and widening and shrinking spread, which is largerly intuitive, but still follows the usual patterns of TA (two or three pushes, channels and climaxes, breakout attempts and follow through or failures) you are no longer afraid to enter anywhere, even chasing strong momentum for another few to several pips. An example of a chase entry attached (incidentally, it was stopped out, but was still an okay entry and ended up breakeven).

The Setup? Call it whatever -- Breakout Pullback Long, High 1, Tight Channel Long on Pullback, doesn't matter. The main point was that the bears who entered on the quality signal bar likely were scared to fade that strong move and had their breakeven stops in, which were the target. Whether they would be cleared or not (they weren't) was yet to be seen, but they were obviously the next clear target both for chasing bulls and fearful early shorts.

Today I want to share the technical setup for trading tight based on the breakeven concept. Even if one is trading with wide stops, this technical setup is very useful, especially for newbies, because it helps save many pips that would be otherwise given to the broker or to the market:

- ECN account with tight spreads: I don't know if these old-school bucket shop accounts with fixed 1-pip or even 3-pip spreads are still used by anyone or available at all, but thought would mention it just in case. Making pips is a competitive business and giving away full pips at both ends of a transaction is for the rich and generous only. You need a proper ECN account, which nowadays can be opened starting from USD 200, where you have real market spreads in the 0.2-0.5 range. It makes a huge difference as far as playing from Breakeven is concerned. I will not mention any brokers, do your own research.
- A One-Click Order Tool: Again, probably most people use them now, but some newbies may not be aware of this. This is a tool that lets you place bracket orders with predetermined sl/tp levels, lets you take partial profits on the first touch of the target area, automatically sets your position to breakeven at the specified level, automatically trails your sl order, lets you throw stop and limit orders at predetermined distance from the market price. There are many such tools available, either from the brokers or from developers, either free or paid. Search around for them (won't mention any specific vendors). So, without going into strategy and decisions when to place orders, which may require some slight adjustments to the One Click Settings (which are simply changed by adjusting data in the windows), my basic setup is this:
- position size: depends on one's money management rules, but smaller preferred, like 0.5-1 pct of account, split into two parts, scaling in at 2-4 pips if initial entry goes against you.
- stop loss max 5 pips: I use a stop loss of 2-5 pips, very tight -- max 5 pips on first entry, max 3 pips on second entry if scaling in. The reason for this is technical: we're either trying to catch a breakout or fade into a stop run climax. A run-of-the-mill unretraced move (spike) in EURUSD, which is always a breakout and a climax at the same time, seldom exceeds 10 pips, and even within those 10 pips, there is usually some micro back and forth fighting in small 1-5 pip ranges, which are visible on the tick chart, and which we're trying to play.
- take profit, a swing target, 30+ pips: The ultimate profit target has to be ambitious because that's what pays us. It can be set at higher timegrame levels. For me a 30 pip profit target is good enough. If you carry half of your position 30 pips, it translates into 15 pips on a full position, and if you manage to keep breakeven entry collateral costs within 10 pips, that's your theoretical risk-reward of 1:1.5. Of course, more ambitious targets can and have to be set on strong trend days.
- first partial profit 30-40 pct, at 2 pips; breakeven stop at 2 pips: This automatically gives you a breakeven position (which has a very high probability of being stopped out, of course). Since the transaction cost is 0.5 pip round, you book a micro profit and stay breakeven on your position. If it's a good fade of a climax on the chart, sometimes you get to ride even 5-8 pips with a trailing stop.
- second partial profit target 20 pct, at 12 pips: this can be set or not set, depending on price action.
- breakeven stop, at 2 pips. But often it helps to keep it half a pip away from the very breakeven level, because it gets run too often, while 0.5-1 pip beyond it allows you to stay in far more often.- trailing stop, can be set at 14 pips or tighter, based on price action.
- after initial entry: scale in at 2-4 pips against the initial entry, but with tighter stop of 2-3 pips max. If price goes back to your first entry or thereabout, the first entry is exited, a partial profit is taken on the second entry and the second entry stop is set to breakeven. There may be more stopouts and re-entries if the tick charts warrants them, breakouts and fakeouts, and you have to use your judgement and intuition and price action reading skills to determine if your trade idea is still valid and what is hapenning in the market.
- once in profit: let the market do its work and make sure the automatic profit targets are set to snatch them at the first touch, trail the stop and don't add into the position unless it has already run far and given you profit.

So this is the basic technical setup. Manual trading like this is very tedious and you lose your edge often, because you fail to snatch the initial profit at first touch manually or set the position to BE. Basically you need those tools or an automatic expert. Here's a picture of the tool I'm using:

Today I want to share the technical setup for trading tight based on the breakeven concept. Even if one is trading with wide stops, this technical setup is very useful, especially for newbies, because it helps save many pips that would be otherwise given to the broker or to the market: - ECN account with tight spreads: I don't know if these old-school bucket shop accounts with fixed 1-pip or even 3-pip spreads are still used by anyone or available at all, but thought would mention it just in case. Making pips is a competitive business and giving...

I learnt about the concept from Bella's book The Playbook initially more than a year ago, then read John Grady's e-book and found the same concept for Forex described by one of the traders featured in Traders at Work by Tim Bourguin. Then started out in futures trading a few months ago and saw what DOM trading is all about and am keen to explore this approach. Welcome to join in with your ideas on how to implement it successfully. I'd been a fan of price action trading and still actually think price action is the only real indicator of market structure (no need for any additional derivative indicators...), but money is only made if you manage to stay in the money in the inside market (the first rows at the spread plus the market orders) for most of the time.

"[quote=StopRunFx;8387146]Today I want to share the technical setup for trading tight based on the breakeven concept. Even if one is trading with wide stops, this technical setup is very useful, especially for newbies, because it helps save many pips that would be otherwise given to the broker or to the market: - ECN account with tight spreads: I don't know if these old-school bucket shop accounts with fixed 1-pip or even 3-pip spreads are still used by anyone or available at all, but thought would mention it just in case. Making pips is a competitive business and giving away full pips at both ends of a transaction is for the rich and generous only. You need a proper ECN account, which nowadays can be opened starting from USD 200, where you have real market spreads in the 0.2-0.5 range. It makes a huge difference as far as playing from Breakeven is concerned. I will not mention any brokers, do your own research. - A One-Click Order Tool: Again, probably most people use them now, but some newbies may not be aware of this. This is a tool that lets you place bracket orders with predetermined sl/tp levels, lets you take partial profits on the first touch of the target area, automatically sets your position to breakeven at the specified level, automatically trails your sl order, lets you throw stop and limit orders at predetermined distance from the market price. There are many such tools available, either from the brokers or from developers, either free or paid. Search around for them (won't mention any specific vendors). So, without going into strategy and decisions when to place orders, which may require some slight adjustments to the One Click Settings (which are simply changed by adjusting data in the windows), my basic setup is this"

helllo StoprunFX....nice job you are doing,i do like to ask about the one click tool you talked about, is the one click tool inbuilt on meta4 platforms able to take partail profit...if so how precisely can i do this, how can the in built one click trading be used for setting break even...........thanks in advance.....maybe a pic or illustration would help.

how can the in built one click trading be used for setting break even...........thanks in advance.....maybe a pic or illustration would help.

Ignored

I think the built-in tool does not allow any of those functions, you have to do them manually, which is tedious and slower than the market moves. Try installing a more advanced tool as an Expert. Hope this helps.

I'm not sure this will work on your platform -- because it's something that came from my broker, try to figure it out yourself by keying in the different parameters and playing with them, or find another tool with full instructions.

Attaching an average good day's result, when trading tight, from around BE. I deliberately analysed that day to compare it with the approach of using wide stops beyond swing highs/lows. Guess what. On that day I had three good runners and three scalps (marked as green arrows), and a dozen of small losers (red arrows) and breakeven trades (blue arrows). Okay, got stopped out BE out of some big moves and missed them (partly because I was away from computer). Still it was a great day results-wise, overall actualrisk-reward ratio ranging within 1:4 or even better. I calculated what I would have gained, in retrospect, had I used wide enough stops to profit from the big moves as well. I would have made 70 pips total, but the risk would have been 53 pips, hypothetical risk-reward of 1:1.3 only. Which is why I think the BE approach is superior by far.

I was going to ask if this video is available on another platform, because it does not show from or play from within forexfactory.
But in replying with quote, I saw the embedded video link to youtube.
So this is just to give you a heads up, that the way the video is embedded, it's not playing on some people's Chrome and Firefox browsers.
(it's playing in youtube now, so all is ok - but it would be nice to be able to see videos without having to click reply-with-quote in order to fetch the link)

Great video StopRunFX, thanks for posting. I've been getting into order book (DOM) trading these last few weeks and it's a real eye opener. This video has answered some of my questions, and the guys's website (http://www.nobsdaytrading.com) has answered even more. I have no affiliation with him, by the way, and have not taken any of his courses (yet!).

One question he answered in the Q&A was why there is sometimes huge spontaneous volume but price doesn't move a tick. I've seen this phenonomon myself recently on 5-second charts, and I thought maybe it was platform error, market manipulation or something. The truth is far less sinister. In a liquid market it's just coincidence that a few smaller orders - some buy, some sell - look like they're coming in as one large order. So price doesn't move. If it were one single buy or sell order and there weren't that many limit orders waiting to fill it, then price would move for sure. The fact that it doesn't means that it was a combination of smaller orders, some buy and some sell.

If I'd seen his webinar in realtime I would have asked him this question at the end:

"Is there any way we can use the DOM ladder to anticipate real breakouts (the start of a new trend) versus false breakouts?"

I have some thoughts about what his answer might be, but first.. what do you guys think?

Hi NorthTrader, do you have a way to watch actual DOM and Time and Sales for spot forex, or do you mean forex futures? On my MT4 platfrom the only alternative to what is DOM in futures is the tick flow chart, which I still find very informative given the spread variation and patterns that form, and I'm using this to time entries. The MT4 DOM tool seems to be useless though. Please share any insights or technical know-how you have.

"Is there any way we can use the DOM ladder to anticipate real breakouts (the start of a new trend) versus false breakouts?" I have some thoughts about what his answer might be, but first.. what do you guys think?

Ignored

If you have any setups or signs, please share them. I don't know if there are any reliable signs of a real vs fake breakout. My only theory about breakouts (and every move beyond a previous level at every tick and every bar or tail high or low is actually a breakout, if you think about it ) is this:

- the actual breakout beyond a level is seldom paid by those who have prepositioned themselves and are already in profit / BE+ (i.e. those who lifted the prices to the level are seldom the ones who clear the limit orders at the level -- with the exception perhaps of an at market run/spike, which happens very quickly);
- instead, those who are prepositioned at BE+ have partial or full profit-taking limit orders at the level or just beyond;
- the breakout is paid by either fresh entries in the same direction and/or exiting guys on the wrong side of the pre-breakout range and/or panicking higher timeframe players who have been suffering a pullback; or a combination of all of the above slowly arriving at consensus that there should be a test beyond the level.

When the breakout occurs and the stops are run and converted into market orders in the breakout's direction, the following will happen:
- early faders of the breakout will step in trying to catch a BE position for a failed breakout, usually fading, exiting and re-entering micro climaxes at market.
- the late entries who paid the breakout will take tiny profits and set their stops to around BE, becoming the next target for a breakout test.
- the higher timeframe players who had been suffering a pullback may use the opportunity to scale into their longer-term positions against the breakout, either at limit or market.
- judging on the aggressiveness of the above action, the prepositioned players now in comfy profit will either panic and exit at market or stop limits failing the breakout, or will follow up by trying to fade a breakout test and to add on to their positions.

There will also be cases where the old players in profit behind the breakout will deliberately cause the breakout to seem to fail, only to run it further afterwards -- that's what Al Brooks calls Failed Failure, which usually leads to a measured move in the original direction: e.g. a bull breakout seems to fail, but then the breakout failure/reversal fails, and the original breakout takes over with renewed force -- you often see this as failed wedge reversals on the chart: a perfecet wedge reversal with a signal bar will only produce an entry bar and break out strongly in the opposite direction running all countertrend stops.

On the futures DOM I've seen this many times: there will be seemingly strong support/resistance at a level with many limit orders providing solid backing several price levels deep. But many of these orders are held by the original players behind the emerging or existing trend, and they will suddenly pull those support/resistance limit orders creating a vacuum for the breakout. Naturally stops are triggered and there is a mess on the DOM, with those sneaky players apparently taking profits and then driving some more at market into the early fader's tight stops -- before there is any prospect of a breakout test. It's that' kind of games we're talking about.

In any case it is always a game involving expanding and contracting ranges and is never safe to play with wide stops -- either they will be still within volatility's reach or they will be too far to provide positive risk-reward on the trade. Once some clarity emerges regarding who is holding the bag and who is comfy after the breakout, those holding the bag will be the next scalp target, and if they manage to see the trap early on, they'll exit at market quickly, driving the price in a spike (either in the breakout direction or counter), which stops suddenly, game will be reset again for a while.

On the chart in retrospect many good breakouts look clean and easy and so do breakout failures, but this is a superficial view because all the battles were fought out on the DOM/tape, judging on who had the better edge of catching a BE position and driving the price at least a little in one's favour, triggering the weaker party to surrender.

Okay, enough, I'm turning this into a ramble . I will try to organise these ideas more coherently in future posts.